The Battle Over Inflation

(April 12, 2011) — Inflation is a primary concern for pension schemes worldwide, yet the all-powerful Federal Reserve is playing down the risk.

In recent weeks, the Fed has encountered heightened pressure from various constituencies to raise interest rates and stop potential inflation. According to the Wall Street Journal, top Fed officials are indicating that the Fed is unlikely to mirror the European Central Bank in lifting interest rates in the near future, calming worries that increases in the prices of oil, grain, and other commodities will result in further inflation in the US. “We think that it’s important not to overreact to a rise in headline inflation because the increase in commodity prices is probably going to be temporary rather than persistent,” William Dudley, president of the Federal Reserve Bank of New York, said in Tokyo, the WSJ reported.

In a statement after its March 15 meeting, the Fed said that “long-term inflation expectations have remained stable.” Consumer prices in the US rose 2.1% in the 12 months ending in February.

Despite the Fed’s efforts to quell fears, investors have continued to voice concerns over inflationary pressures. In the UK, a survey of 64 European pension schemes with more than $426 billion (€300 billion) of assets showed that inflation is the most pressing concern for investors, with 92% of respondents citing it as a slight concern or a serious worry, according to Financial News.

In the US and Canada, a heightened focus on inflation is reflected by an annual survey from Casey Quirk & Associates and eVestment Alliance of investment consultants, which revealed that alternatives, emerging markets, and strategies that provide a hedge against inflation are expected to dominate 2011 search activity. The study showed that half of those surveyed expect an increase in institutional interest in inflation hedging strategies this year. “One of the more interesting findings in this year’s consultant survey is the rising interest in private equity and real assets,” noted Casey Quirk Partner Yariv Itah in a statement. “Institutional investors increasingly manage toward outcomes rather than just excess return, and they want asset managers who can use illiquid investments to mitigate inflation risk and manage liabilities.”

In response to US fiscal concerns, investors have been adjusting their allocations. Pacific Investment Management Co. (PIMCO), for example, has been increasingly shorting US government related debt and raising its cash holdings, largely due to inflation concerns. In June of last year, Bill Gross, chief investment officer of PIMCO, revealed that he would be making a transition into equities. “We are recognizing that the global marketplace is not just bond-oriented, and so equities have a place, always have had a place,” he told CNBC. Mohamed El-Erian, CEO of PIMCO, who popularized the phrase “new normal” to describe how growth will be depressed by consumer retrenchment and tighter financial regulation, has said the Fed’s purchase of Treasuries will lead to faster global inflation while failing to revive US economic growth. Thus, he has warned that investors should expect lower-than-average historical returns with greater regulation, lower consumption, slower growth, and a shrinking global role for the US economy.